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To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Island Pharmaceuticals (ASX:ILA), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Island Pharmaceuticals is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
-0.33 = -AU$2.1m ÷ (AU$6.6m - AU$237k) (Based on the trailing twelve months to June 2021).
Thus, Island Pharmaceuticals has an ROCE of -33%. In absolute terms, that's a low return and it also under-performs the Pharmaceuticals industry average of 5.9%.
View our latest analysis for Island Pharmaceuticals
Historical performance is a great place to start when researching a stock so above you can see the gauge for Island Pharmaceuticals' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Island Pharmaceuticals, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
There hasn't been much to report for Island Pharmaceuticals' returns and its level of capital employed because both metrics have been steady for the past . Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So unless we see a substantial change at Island Pharmaceuticals in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.
What We Can Learn From Island Pharmaceuticals' ROCE
In summary, Island Pharmaceuticals isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained over the last . Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you want to know some of the risks facing Island Pharmaceuticals we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.